What is capital gains tax and how does it relate to property?

Navigating capital gains tax is an unavoidable part of investing, but the complexity around this long-standing feature of Australia’s tax system can make it a daunting task.

Introduced in 1985, this is a tax paid to the federal government on any profits you make when you dispose of an investment asset like a property or shares.

While your family home is generally exempt (provided it’s your primary residence), any investment properties you own will likely be subject to it. This is just one of many rules that can cause confusion among investors.

“There are a lot of intricacies, a lot of different rules inside rules, and exemptions that people can benefit from,” says principal advisor at Property Tax Specialists, Amir Ishak. “They’re all in the legislation but you have to know where to find them.”

A capital gain or loss can significantly impact the tax you pay at the end of the financial year, so it’s crucial to know what capital gains tax is and how it works.

What is capital gains tax?

Put simply, a capital gain or loss is the difference between what you pay for an asset and what you sell it for. 

If you make a profit or loss on an asset subject to capital gains tax (CGT), you must declare it to the Australian Taxation Office as part of your income tax return for that financial year. 

A capital gain forms part of your assessable income and will be taxed at your marginal income tax rate. However, this can be offset by any capital losses realised that same year or carried forward from previous tax years.

If you are an Australian resident and have owned the asset in question for at least 12 months, you will generally be eligible for a CGT discount of 50 per cent.

Wakelin Property Advisory director Jarrod McCabe says this 12-month rule is something property investors need to be aware of.

“In order to minimise capital gains tax, you do need to hold a property for 12 months,” he explains. “If you sell it inside 12 months – and there are not many who do – and make a handsome profit, well you pay capital gains tax on the full amount.”

What is a capital gain?

A capital gain is the profit earned on an asset when you sell or dispose of it.

The types of assets that are subject to capital gains tax in Australia include:

• Property, excluding your primary residence
• Shares
• Crypto assets
• Personal use assets that cost you more than $10,000, including boats, furniture, electrical goods and household items
• Collectables that cost you more than $500, including artwork, jewellery, antiques, coins, postage stamps, and rare folios, manuscripts or books
• Intangible assets like leases, goodwill, licences and contractual rights
• Foreign currency

If you’re unsure whether an asset is subject to capital gains tax, the ATO website is an excellent place to find more information. The ATO also has a capital gains tax calculator that can be used to calculate your net capital gain or loss.

When do you have to pay capital gains tax?

You must pay capital gains tax when a ‘CGT event’ occurs – commonly when an asset is sold, traded or lost.

Any capital gains or losses realised when you dispose of an asset must be added to your tax return for that same income year. 

Importantly, if there is a contract of sale, the CGT event happens at the point when you enter into the contract. So, when it comes to property, a capital gain or loss occurs when a contract is signed, not on the settlement date.

Ishak says property investors should consider capital gains tax from the very beginning of their property journey.

“People usually look at negative gearing and short-term how much tax they’ll save, but the bigger issue is at the end when they sell, they usually make a lot more on capital gains and that’s what a lot of people don’t look at.”

How much is capital gains tax?

Provided you have records of how much you paid for an asset, calculating your capital gain or loss – the difference between the purchase price and the sale price – should be relatively straightforward.

Selling the asset for more than it originally cost results in a capital gain; selling it for less results in a capital loss. 

You may be able to add some of the costs associated with buying, holding and disposing of a property, such as legal fees and stamp duty, to the asset cost base when making these calculations.

Your net capital gain – your total capital gain minus any capital losses, exemptions and discounts – is added to your income tax return for that year and taxed at your marginal tax rate. 

“Sometimes, people don’t understand that it’s to do with their tax rate,” says McCabe. “There can sometimes be misunderstandings there.”

If you give an asset away or sell it for less than it is worth, your capital gain or loss will be based on its market value.

Capital gains tax exemptions and discounts

Calculating your loss or gain should be easy enough. However, many exemptions and discounts could apply, in addition to the 50 per cent discount you can receive for owning an asset for more than 12 months.

The principal residence exemption is “one of the most generous”, says Ishak. “If you buy a house and move in on settlement … that property, as long as you have no other property that you’re claiming as your main residence, is tax-free when you sell it.”

However, if your property was used to make money, you may be required to pay capital gains tax when you sell it.

“If it was used to generate income, if part of it was used to generate income, if there’s a granny flat at the back that was rented out – all of these have tax implications,” says Ishak.

If you move away and start renting out your former home but don’t have another primary residence, the principal residence exemption can be extended for up to six years under what’s known as the “six-year rule”.

Property investors can also reduce their overall taxable income by claiming deductions for expenses related to their investment property, such as agent fees, council rates, and the costs of repairs or maintenance. 

“One of the key mistakes that people make is not keeping good records,” Ishak says. “If you don’t have good records, you don’t know what you can claim and you could lose out on big big dollars.”

Making claims without the records to back them up can get investors into trouble, he warns.

“The ATO is very active with audits now and if you sell a property, it’s automatically reported by the state revenue offices to the ATO,” Ishak says. “The more records they keep, the better because then they can substantiate it should there be an audit.”

Assets acquired before the legislation was introduced on September 20, 1985, are exempt from capital gains tax.

Considering the complexity of this tax, both McCabe and Ishak recommend seeking expert advice at tax time.

“We will certainly instruct and advise our clients to speak to an accountant so they can maximise what they can and can’t claim,” says McCabe.